The benefits and costs of adjusting bank capitalisation: evidence from euro area countries

Katarzyna Budnik (katarzyna.budnik@ecb.europa.eu), Massimiliano Affinito, Gaia Barbic, Saiffedine Ben Hadj, Edouard Chretien, Hans Dewachter, Clara Gonzalez, Jenny Hu, Lauri Jantunen, Ramona Jimborean, Otso Manninen, Ricardo Martinho, Javier Mencía, Elena Mousarri, Laurynas Naruševičius, Giulio Nicoletti, O’Grady, Michael, Selcuk Ozsahin, Ana Regina Pereira, Jairo Rivera-Rozo, Constantinos Trikoupis, Fabrizio Venditti and Sofia Velasco

No 2261, Working Paper Series from European Central Bank

Abstract: The paper proposes a framework for assessing the impact of system-wide and bank-level capital buffers. The assessment rests on a factor-augmented vector autoregression (FAVAR) model that relates individual bank adjustments to macroeconomic dynamics. We estimate FAVAR models individually for eleven euro area economies and identify structural shocks, which allow us to diagnose key vulnerabilities of national banking systems and estimate short-run economic costs of increasing banks’ capitalisation. On this basis, we run a fully-fledged cost-benefit assessment of an increase in capital buffers. The benefits are related to an increase in bank resilience to adverse shocks. Higher capitalisation allows banks to withstand negative shocks and moderates the reduction of credit to the real economy that ensues in adverse circumstances. The costs relate to transitory credit and output losses that are assessed both on an aggregate and bank level. An increase in capital ratios is shown to have a sharply different impact on credit and economic activity depending on the way banks adjust, i.e. via changes in assets or equity. JEL Classification: E51, G21, G28

Keywords: banking system resilience; capital regulation; cost-benefit analysis; FAVAR (search for similar items in EconPapers)
Date: 2019-04
New Economics Papers: this item is included in nep-ban, nep-cba, nep-eec and nep-fdg
Note: 1355359
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Working Paper: The benefits and costs of adjusting bank capitalisation: evidence from euro area countries (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20192261

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